Intermediate Accounting Final - Study Guide

Accounting Concepts and Assumptions

1. Economic Entity Concept - presumes that economic events can be identified specifically with an economic entity.

2. Going Concern Assumption - in the absence of information to the contrary, it is anticipated that a business entity will continue to operate indefinitely.

3. Monetary Unit Assumption - states that financial statement elements should be measured in terms of the United States dollar.

4. Historical Cost Principle - states that asset and liability measurements should be based on the amount given or received in the exchange transaction.

5. Realization Principle - revenue should be recognized when the earnings process is virtually complete and collection is reasonable assured.

6. Matching Principle - expenses are recognized in the same reporting period as the related revenues.

7. Full-Disclosure Principle - any information useful to decision makers should be provided in the financial statements, subject to the cost effectiveness constraint.

8. Periodicity - the life of a company can be divided into artificial time periods to provide timely information to external users.

9. Conservatism - is a justification for some accounting practices, not a desired qualitative characteristic financial information.

10. Relevance - to be useful decision making, information should possess the qualities of relevance and faithful representation.

11. Faithful Representation - means agreement between a measure and a real-world phenomenon that measure is supposed to represent.

12. Comparability - accounting information should be comparable across different companies and over different time periods.

13. Verifiability - implies a consensus among different measurers. 14. Consistency - permits valid comparisons between different periods.15. Timeliness - information that is available to users early enough to allow its use in the

decision process.16. Reliability - the extent to which information is verifiable, representationally faithful, and

neutral. 17. Materiality - if a more costly way of providing information is not expected to have a

material effect on decisions made b those using the information, the less costly method may be acceptable.

18. Industry Practice - when accounting standards requires firms in a given industry to use accounting principles different from the norm for most companies.

19. Cost Effectiveness - the perceived benefit of increased decision usefulness exceeds the anticipated cost of providing that information.

Not Sure if on Test - But Helpful either way.

1. True. A physical inventory should be taken at least once a year even when a perpetual inventory system is used.

2. False. When goods are shipped FOB shipping point, title passes only when the seller receives full payment for the merchandise. (Title passes at shipping point)

3. False. Freight out costs should be included in the cost of inventory. (Is a selling expense)4. True. Freight in costs should be included in the cost of inventory. (Part of getting it ready

for sale)5. True. The use of a Purchased Discounts Lost account indicates that the purchases are

being recorded net of purchase discounts. (Would be added to sales or treated as interest expense)

6. False. A major argument in favor of FIFO is that current costs are matched against current revenues. (As stated, this is the argument for LIFO)

7. True. If LIFO is used for tax purposes, it must also be used for financial reporting purposes. (This is the LIFO Conformity Rule)

8. False. If FIFO is used for tax purposes, it must also be used for financial reporting purposes. (There is no such thing as FIFO Conformity Rule)

9. True. Under dollar value LIFO, there will never be a layer multiplied by the index for that particular year unless the quantity of inventory increased during that year.

10. True. Under periods of rising prices, FIFO tends to give a lower Cost of Goods Sold and higher Net Income. (LIFO tends to give lower net income and lower tax under rising prices as FIFO does opposite)

11. False. Sales Discounts has a credit balance. (Contra to sales....so has to have debit balance)

12. False. Trade Discounts on Purchases are carried in the books as a credit balance. (Calculated to get true selling price but does not appear on books as separate account)

13. True. Purchase Discounts Not Taken can be reported in the books as Interest Expense.14. False. A NSF check is discovered on the bank statement would be subtracted from the

bank balance side on the bank reconciliation. (Would be subtracted on the book side....example of testing any part of the bank reconciliation)

15. True. An investment with an initial maturity date of less than 3 months would be considered a cash equivalent.

1. True. The Statement of Financial Position is another name for the Balance Sheet.2. False. A Balance Sheet is prepared after six months in business would be dated "For the

Six Months Ending...".3. False. Accounts Receivable is a type of Liability.4. False. Sales are not recorded until cash is received.5. True. Supplies are usually carried on the Balance Sheet at historical cost even if their

market value is less.6. False. If land is listed on the Balance Sheet for $15,000 that means it would probably sell

for $15,000.7. True. Mortgage Payable is a type of Liability.8. True. A Retained Earnings account is used by corporation, but not by partnerships.

9. False. The Statement of Activity is another name for the Balance Sheet.10. False. If a company has a positive net income, cash must have increased during the year.11. True. Assets less Liabilities equals Owner's Equity.12. True. Assets less Owner's Equity equals Liabilities.13. False. Commissions Earned is a type of Liability.14. False. A repayment of the principle on a loan is an expense. 15. True. Cash received from a loan is not a revenue.16. False. The amount of Supplies Expense on the Income Statement represents the amount

of cash paid for supplies during the year.17. True. The amount of Supplies Expense on the Income Statement represents the amount

of supplies used up during the year.18. False. The Statement of Cash Flows is dated as a single date, such as June 30, 2011.19. True. Repayments of loan interest appear in the Operating Section of the Statement of

Cash Flows.20. True. Repayments of loan interest appear in the Operating Section of the Statement of

Cash Flows.21. False. Interest Revenue appears in the Investing Section of the Statement of Cash Flows.22. False. Dividends Received on investments appear in the Investing Section of the

Statement of Cash Flows.23. True. A Purchase of a building for cash appears in the Investing Section of the Statement

of Cash Flows.24. False. A sale of land for cash appears in the Operating Section of the Statement of Cash

Flows.25. True. The payment of a dividend on the company's own stock is listed as an outflow

under the Financing Section of the Statement of Cash Flows.

• What is the difference in Operating Net Income and Continuing Net Income?

Operating Net Income includes revenues and expenses directly related to principal revenue-generating activities of the company. For Example, operating income for a manufacturing company includes sales revenues from selling the products it manufactures as well as all expenses related to this activity. Continuing Net Income operations include the revenues, expenses, gains and losses that will probably continue in future periods.

• What kinds of items appear in Non-Operating Section?Non-operating relates to peripheral or incidental activities of the company. For example, a manufacturer would include interest and dividend revenue, gains and losses from selling investments, and interest expense in non-operating income. Other income expense often is the classification heading companies use in the income statement for non-operating items. On the other hand, a financial institution like a bank would consider those items to be a part of operating income because they relate to the principle revenue-generating activities for that type of business.

• What is the criteria to be called Extraordinary?

Extraordinary items are "red flagged" in an income statement by being reported separately, net of tax, and appropriately labeled. Extraordinary items are material events and transactions that are both:

1. Unusual in nature2. Infrequent in occurrence

These criteria must be considered in light of the environment in which the entity operates. There obviously is a considerable degree of subjectivity involved in the determination.

• Adjusting Entries

• Adjusting Entries - internal transactions recorded at the end of any period when financial statements are prepared.

• The prepaid insurance account had a normal balance of $4,000 at the beginning of the year. Another $1,000 of insurance was purchased during the year. This particular company chose to debit the $1,000 purchase to Insurance Expense instead of prepaid. At the end of the year only $1,500 of insurance will carry over to next year (unexpired). Show your work in analyzing the situation and the Adjusting entry that is needed. (4,000 - 1,500 = 2,500)

Entry: Insurance Expense $2,500Prepaid Insurance $2,500

• The company bought Equipment January 1 with a five year life for $50,000. Now 1/10 of the asset benefits have been used up. (50,000 x .10 = 5,000)

Entry: Accumulated Depreciation $5,000Depreciation Expense $5,000

• The supplies account had a normal balance of $1,000 at the beginning of the year. An additional $3,000 of supplies were purchased during the year and debited to Supplies Asset. A count now shows that only $300 of supplies are still in the supplies cabinet unused. Analyze the situation and show the adjusting entry. (3,000 + (1,000 - 300) = 3,700)

Entry: Supplies Expense $3,700Supplies $3,700

• The employees are paid every Friday for the current week's work. The total salaries are $300 per day. The end of the year falls so that the employees have worked Monday, Tuesday, and Wednesday. Wednesday falls on the 31st. What entry if any would be made on Wednesday since the will not really receive checks until Friday? (300 x 3 = 900)

Entry: Salaries Expense $900Salaries Payable $900

• On December 15, the company took a deposit of $12,000 for work to be done and recorded it as Earned Revenue even though the work had not yet been done. As of December 31, 1/4 of the work has now been completed. (12,000 x .25 = 3,000)

Entry: Earned Revenue $9,000Unearned Revenue $9,000

• Closing Entries

• Closing Process - serves a dual purpose: (1) the temporary accounts (revenues, expenses, gains and losses) are reduced to zero balances, ready to measure activity in the upcoming accounting period, and (2) these temporary account balances are closed (transferred) to retained earning to reflect the changes that have occurred in that account during the period.

  WHERE WOULD THE FOLLOWING ITEMS MOST LIKELY APPEAR ON A CLASSIFIED BALANCE SHEET.   PUT BRACKETS AROUND THE ITEM IF IT WOULD BE A CONTRA ACCOUNT IN THAT CATEGORY. A.  Current Assets D. Intangible Assets G. NonCurrent Liabilities      J. Retained EarningsB.   Investments             E. Other Assets             H.  Capital Stock, parX. Does not appear on B/Sheet C.  Prop Plant & Eq        F. Current Liabilities

I.  Additional Paid In Capital _____1.   Preferred Stock of our own company_____2. Trade accounts payable_____3. Trading securities_____4. Available for sale securities_____5. Current portion of long term debt_____6. Premium on 20 year bonds payable_____7. Discount on notes payable due in 9 mons_____8.   Allowance for doubtful accounts_____9.   Notes receivable due in 15 months_____10. Cash surrender value of life insurance_____11. Office supplies used_____12. Unearned magazine subscription revenue_____13. Taxes payable_____14. Deficit (HINT: Deficit = neg balance in RE)_____15. Treasury Stock_____16. Land held for speculation_____17. Bond sinking fund_____18. Unexpired insurance_____19. Preferred Stock in another Co. owned by us_____20. Advances to suppliers to be used up in  6 months_____21. Premium on our own common stock

_____22. Petty cash fund_____23. Sales tax payable_____24. Amount due government for property taxes_____25. Fully depreciated machinery still in use_____26. Depreciation expense_____27. Budgeted Salaries to be paid for work next year_____28. Goodwill_____29. Copyrights_____30. Stock dividend to be distributed next month_____31. Cash Dividend declared & payable next month_____32. Cash restricted for planned plant expansion_____33. Retained Earnings – Unappropriated_____34. Retained Earnings --- Appropriated or Restricted in use_____35. Twenty year bonds payable which will be due next year (no sinking fund established)_____36. Discount on bonds payable from #35_____37. 3 months advance rent received by landlord_____38. 3 months advance rent paid by company to landlord_____39. Finished Goods_____40. Work in Process_____41. Accumulated Depreciation_____42. 6 months of interest accrued on 20 year bond_____43. Cost of an oil well for Exxon_____44. Accumulated Depletion_____45. Restricted Retained Earnings_____46. A $50 overdraft in the company bank account_____47. Amortization expense_____48. Sales Discount

• Income Statement

• The purpose of the Income Statement is to summarize the profit-generating activities of a company that occurred during a particular of time. It is a change statement in that it reports the changes in shareholders' equity (retained earnings) that occurred during the period as a result of revenues, expenses, gains, and losses.

• Balance Sheet

• The purpose of the Balance Sheet is to present the financial position of the company on a particular date. Unlike the income statement, which is a change statement reporting events that occurred during a period of time, the balance sheet is a statement that presents an organized list of assets, liabilities, and shareholders' equity at a point in time. The Balance Sheet is grouped into Current Assets and Current Liabilities. Current Assets are those assets that are cash, will be converted into cash, or will be used up within one year or the operating cycle, whichever is longer. Current liabilities are those liabilities that will be satisfied within one year or the operating cycle, whichever is longer.

• Statement of Cash Flows

• Similar to the income statement, the Statement of Cash Flows also is a change statement, disclosing the events that caused cash to change during the period. The statement classifies all transactions affecting cash into one of three categories: (1) Operating Activities, (2) Investing Activities, and (3) Financing Activities. Operating activities are inflows and outflows of cash related to transactions entering into the determination of net income. Investing activities involve the acquisition and sale of (1) long-term assets used in the business and (2) non-operating investment assets. Financing activities involve cash inflows and outflows from transactions with creditors and owners.

Chapter 9

1. Lower-of-cost-or-market (LCM) - recognizes losses in the period that value of inventory declines below its cost.

2. Net Realizable Value (NVR) - the amount of cash the company expects to actually collect from customers.

3. Net Realizable Value less a Normal Profit Margin (NVR - NP) - lower limit of market.4. Replacement Cost - the cost to replace the item by purchase or manufacture. 5. Gross Profit Method (Gross Margin Method) - estimates cost of goods sold which is then

subtracted from cost of goods available for sale to estimate ending inventory.

6. Retail Inventory Method - relies on the relationship between cost and selling price to estimate ending inventory and cost of goods sold; provides a more accurate estimate than the gross profit method.

7. Cost-to-retail-percentage - ratio found by dividing goods available for sale at cost by goods available for sale at retail.

8. Net Markdown - net effect of the change in selling price (increase, decrease, increase).9. Net Markup - net effect of the change in selling price (increase, increase, decrease).10. Conventional Retail Method - applying the retail inventory method in such a way that

LCM is approximated. 11. Dollar-value LIFO Retail Method - LIFO retail method combined with dollar-value

LIFO.12. Purchase Commitments - contracts that obligate a company to purchase a specified

amount of merchandise or raw materials at specified prices on or before specified date.

• Gross Profit Challenge ProblemABC Co. had its inventory damaged by fire in December just before physical inventory was taken. Fortunately, the accounting records were backed up and stored off site. These records show:

Inventory (Beginning) $80,000 Sales $415,000Purchases $280,000 Sales Returns $15,000Purchase Returns & Discounts 10,000

On average merchandise sold is marked up 33 1/3% above Cost.Merchandise with Selling Prices of $20,000 was undamaged after the fire.Remaining merchandise with smoke damage was sold for $5,000. The company's fire insurance deductible is $100,000.

COMPUTE THE AMOUNT OF THE FIRE LOSS.

ABC CompanyInventoryYear 2011

Beginning Inventory $80,000Plus: Net Purchases (280,000-10,000) 270,000Cost of Goods Available for Sale 350,000

Less: Cost of Goods Sold:Net Sales $400,000Less: Estimated Gross Profit (100,000)Estimated Cost of Goods Sold (300,000)Estimated Ending Inventory 50,000Less: Value of Damaged Goods (20,000)Estimated Loss from Fire $30,000

• Gross Profit Method

The Gross Profit Method, also known as the Gross Margin Method, is useful in situations where estimates of inventory are desirable. The technique is valuable in a variety of situations:1. In determining the cost of inventory that been lost, destroyed, or stolen.2. In estimating inventory and cost of goods sold for interim reports, avoiding the expense

of a physical inventory count.3. In auditors' testing of the overall reasonableness of inventory amounts reported by clients.4. In budgeting and forecasting.

Lower Cost of Market Example: